Qualified Overtime Compensation Deduction

The qualified overtime compensation deduction is the deduction created by Internal Revenue Code section 225 for the premium portion of overtime pay. The statute defines qualified overtime compensation as overtime compensation required under section 7 of the Fair Labor Standards Act of 1938 "that is in excess of the regular rate" at which the individual is employed, so what is deductible is the increment above ordinary pay rather than the overtime wages as a whole. It applies to tax years beginning after December 31, 2024, and section 225(g) allows no deduction for any year beginning after December 31, 2028. It is claimed on Schedule 1-A (Form 1040), and section 63(b)(6) makes it available whether or not the taxpayer itemizes. The IRS heads the relevant part of the form "No Tax on Overtime," which describes the political intent rather than the mechanism: this is a deduction against income, and the overtime remains wages for employment tax purposes.

The premium half is the deduction, and this is where most descriptions go wrong. Section 7 of the Fair Labor Standards Act requires a covered non-exempt employee to be paid at least one and a half times the regular rate for hours over forty in a workweek. Section 225(c)(1) reaches only the part of that payment "in excess of the regular rate." So of a $45 overtime hour paid to someone whose regular rate is $30, the deductible amount is $15. The other $30 is ordinary wages that would have been paid for a straight-time hour anyway. A reader who assumes the whole overtime paycheck is deductible will overstate the benefit by a factor of three on time-and-a-half.

"Regular rate" is a Fair Labor Standards Act term of art, not your base hourly wage. Section 225(c)(1) borrows the phrase "as used in such section," which imports the Act's own definition. The regular rate includes certain non-discretionary bonuses, shift differentials and similar payments, so the computed regular rate for an overtime week can exceed the hourly figure on an offer letter, and the premium is measured against the higher number. That is the employer's calculation rather than the worker's, which is why the deduction depends on what the payor reports.

Overtime that is not federally required does not qualify. The gate is section 7 of the Act, so a premium owed only because a state law or a collective bargaining agreement requires it is outside section 225 even though the paycheck says overtime. Daily-overtime rules, premiums for a sixth or seventh consecutive day worked, and contractual overtime for an employee who is exempt from the Act are all in that category. Conversely, an employee who is exempt from the Act's overtime requirement has no federally required overtime at all, so paid overtime for an exempt salaried worker produces nothing here.

No double counting with tips, and no specified-service exclusion. Section 225(c)(2) provides that qualified overtime compensation does not include any qualified tip as defined in section 224(d), so an amount cannot be run through both deductions. In the other direction, section 225 contains no equivalent of the specified service trade or business exclusion that limits the tips deduction, so a worker in a law firm, a medical practice or a consultancy is not shut out of this one on that basis.

The phase-out is identical to the tips deduction's, including the rounding. Section 225(b)(2)(A) reduces the deduction by $100 for each $1,000 by which modified adjusted gross income exceeds $150,000, or $300,000 on a joint return, and section 225(b)(2)(B) defines modified adjusted gross income as adjusted gross income increased by amounts excluded under sections 911, 931 and 933. Schedule 1-A instructs that the excess divided by $1,000 be decreased to the next lower whole number, which rounds in the taxpayer's favor. Since a substantial share of federally required overtime is worked by people well below $150,000, the phase-out bites mainly on households where a second income lifts the total.

What it does not change. Section 63(b)(6) places the deduction in the list a non-itemizer subtracts from adjusted gross income, which is why it reaches hourly workers who would never itemize. It does nothing to employment tax: overtime is wages, so the employee's 6.2 percent Social Security and 1.45 percent Medicare tax and the employer's matching share apply to the whole overtime payment, premium included. Section 225(d) requires the worker's Social Security number on the return and section 225(e) requires a married taxpayer to file jointly.

The deduction depends on reporting that is new. Section 225(a) allows the deduction only for qualified overtime compensation "included on statements furnished to the individual" under section 6041(d)(4) or section 6051(a)(19), which are the provisions requiring payors to break out the figure. The 2026 Form W-2 carries it as Box 12 code TT. A worker whose employer has not separately reported the premium has a substantiation problem rather than an eligibility problem, and the fix is with the employer.

The sequence is short, and step two is the one people skip.

1. Confirm the overtime was required by section 7 of the Fair Labor Standards Act, rather than by a state law or a contract.
2. Take only the premium, meaning the part paid in excess of the regular rate, and exclude anything that is a qualified tip.
3. Apply the cap of $12,500, or $25,000 on a joint return.
4. Apply the phase-out: subtract $150,000 ($300,000 joint) from modified adjusted gross income, divide by $1,000, decrease to the next lower whole number, multiply by $100, and subtract.

A hypothetical example. Devi is single and her regular rate is $30 an hour. Over the year she works 300 hours of federally required overtime at time-and-a-half, so $45 an hour, and is paid $13,500 for those hours. Only the premium is qualified overtime compensation: $15 an hour on 300 hours, which is $4,500. The other $9,000 is ordinary wages. Her deduction is therefore $4,500, comfortably under the $12,500 cap, and her modified adjusted gross income is far below $150,000 so nothing phases out.

The whole $13,500 remains in the Social Security and Medicare base, so the 7.65 percent employee share on it, about $1,033, is unaffected by the deduction.

The cap tells you who this provision is really limited for. At Devi's $15 premium she would need roughly 833 overtime hours in a year to reach $12,500, which is sixteen hours a week every week. A worker with a $60 regular rate has a $30 premium and reaches the same cap at about 417 hours. The cap binds on rate, not on effort.

Pros

• Available to non-itemizers, which is the population that works most federally required overtime.
• The cap is doubled on a joint return, so a two-earner household with two overtime workers is not squeezed into one allowance.
• The phase-out rounds the income excess down, and the thresholds sit above most hourly earnings.
• No specified-service-business exclusion, unlike the companion tips deduction.

Cons

• Only the premium qualifies, so the deduction is a fraction of what the phrase "no tax on overtime" suggests.
• Overtime required by state law or a contract rather than by federal law does not qualify at all, which excludes daily-overtime and consecutive-day premiums.
• It is a deduction rather than an exclusion, so Social Security and Medicare tax on the overtime is unchanged and the income tax value depends on your bracket.
• It expires for tax years beginning after 2028 and none of its dollar figures is indexed.
• It depends on the employer separately reporting the premium, and a worker cannot supply that figure unilaterally.
• A married worker filing separately cannot claim it.